Get ready for a drop in auto prices

It seems that each new bubble brings forth claims that,
although the bubble may be the result of artificially created
demand, prices of this or that product will not fall and may
even continue to rise. How many so-called real estate and
financial planning “experts” claimed that the surest path to
financial security was in buying the largest house possible
with the least amount of one’s own money?

The Boom: McMansions and Luxury Cars

Since home prices never go down — we were told — the gain from
using OPM (other people’s money) resulted in huge multiples of
gain for the little invested of one’s own money. Thus, in the
first decade of the new century, Americans were buying
so-called McMansions: huge homes with every imaginable feature.
When the bubble burst, the leverage effect worked in reverse.
Mortgage balances far exceeded the lower market price, creating
the so-called “underwater mortgage.” Lower prices had wiped out
not only the little equity contributed by the buyer, but
created a negative equity balance. Buyers abandoned their heavy
mortgages and sought smaller, lower priced homes. It turned out
that home prices did not grow to the sky, as the pundits had
predicted.

The same is true of automobiles, and especially those bought
with auto loans. Easy credit has enticed car buyers into ever
more luxurious and amenity-laden vehicles. It is nearly
impossible today to buy a new car that is not loaded with
luxury entertainment, navigation, and safety features that were
unknown only a few years ago.

Many of these features would never have been sold in such
quantities without the benefit of easy credit. As a frequent
car rental customer, I have been exposed to these features and
have found them difficult to use at best and completely
unnecessary and distracting at the worst. On a recent business
trip my modest sized four door Buick sedan’s speedometer was
projected onto the windscreen and the lane proximity warnings
beeped at me constantly. I never did figure out how to turn off
these annoying devices, which, I admit, may be desired by a
marginal few drivers. But we Austrians know that all economic
choice is based on a hierarchy of preferences. The cost of each
preference is measured in the alternative preferences one
sacrifices. Make some preferences cheaper and they move up our
personal scale. Easy auto credit meant that buyers did not have
to sacrifice as many alternative uses for their money.

Last week, Tommy Behnke in Mises
Dailypredicted that auto prices will
fall as the bubble bursts from the artificially
created demand generated from excessive credit creation. Behnke
pointed out that car production has increased a whopping 100
percent since 2009, but that apologists for government’s
monetary stimulus programs see this fact as proof of the
success of their Keynesian, aggregate demand hypothesis.

An
aerial picture shows new Chevrolet cars at a General Motors'
parking lot in ShenyangThomson
Reuters

Behnke, on the other hand, took the Austrian perspective that
the government has simply substituted a bubble in subprime auto
loans for the bubble in subprime home loans. As defaults rise
and automobile loan credit tightens, the result will be the
same. Namely, a flood of used cars, and falling prices. The
same happened with homes following the burst of the last
bubble: a flood of “used” houses, and falling prices.

Surprisingly, the article attracted a number of reader comments
predicting that used car prices would not fall, allegedly due
to increases in complexity of cars or increases in the
difficulty of repairing them. Another suggestion was that large
dealers will dominate the used car market and simply raise
prices at will.

While it’s certainly true that government interference — such
as Cash for Clunkers — can raise the prices of cars, it is not
true that private dealers (or any other private party) can
simply raise the price. More complex and difficult-to-fix cars
will not keep prices from falling in an environment in which
the inventory of used cars is increasing.

Used Car Dealer or Used Car Collector?

There is one thing that we can know a priori: that an
increase in the supply of some good or a drop in its demand
will cause its price to be lower than that which it
otherwise would be. There is no other way to clear the
market.

Mises explained that, eventually, even a monopolist would
prefer any price to zero price. Maintaining a price above the
market clearing price produces zero revenue. In a flooded
used-car market, car dealers must reduce their prices in order
to avoid bankruptcy. Otherwise, the used car dealer ceases to
be a dealer and becomes a collector. The laws of supply and
demand have not been rescinded, even in a world with very
expensive-to-build and complex cars. As the automobile bubble
bursts, quality used cars will flood the market, creating a
buying opportunity for those with cash.

As with houses, it doesn’t matter how big or luxurious or
complex you make new cars. When the credit bubble bursts, auto
prices will not “always go up.”

Note: The views expressed on
Mises.org are not necessarily those of
the Mises Institute.